Best of the Week
Most Popular
1. Market Decline Will Lead To Pension Collapse, USD Devaluation, And NWO - Raymond_Matison
2.Uber’s Nightmare Has Just Started - Stephen_McBride
3.Stock Market Crash Black Swan Event Set Up Sept 12th? - Brad_Gudgeon
4.GDow Stock Market Trend Forecast Update - Nadeem_Walayat
5.Gold Significant Correction Has Started - Clive_Maund
6.British Pound GBP vs Brexit Chaos Timeline - Nadeem_Walayat
7.Cameco Crash, Uranium Sector Won’t Catch a break - Richard_Mills
8.Recession 2020 Forecast : The New Risks & New Profits Of A Grand Experiment - Dan_Amerman
9.Gold When Global Insanity Prevails - Michael Ballanger
10.UK General Election Forecast 2019 - Betting Market Odds - Nadeem_Walayat
Last 7 days
Investing lessons from the 1987 Stock Market Crash From Who Beat it - 20th Oct 19
Trade Wars: Facts And Fallacies - 20th Oct 19
The Gold Stocks Correction and What Lays Ahead - 19th Oct 19
Gold during Global Monetary Ease - 19th Oct 19
US Treasury Bonds Pause Near Resistance Before The Next Rally - 18th Oct 19
The Biggest Housing Boom in US History Has Just Begun - 18th Oct 19
British Pound Brexit Chaos GBP Trend Forecast - 18th Oct 19
Stocks Don’t Care About Trump Impeachment - 17th Oct 19
Currencies Show A Shift to Safety And Maturity – What Does It Mean? - 17th Oct 19
Stock Market Future Projected Cycles - 17th Oct 19
Weekly SPX & Gold Price Cycle Report - 17th Oct 19
What Makes United Markets Capital Different From Other Online Brokers? - 17th Oct 19
Stock Market Dow Long-term Trend Analysis - 16th Oct 19
This Is Not a Money Printing Press - 16th Oct 19
Online Casino Operator LeoVegas is Optimistic about the Future - 16th Oct 19
Stock Market Dow Elliott Wave Analysis Forecast - Video - 16th Oct 19
$100 Silver Has Come And Gone - 16th Oct 19
Stock Market Roll Over Risk to New highs in S&P 500 - 16th Oct 19
10 Best Trading Schools and Courses for Students - 16th Oct 19
Dow Stock Market Short-term Trend Analysis - 15th Oct 19
The Many Aligning Signals in Gold - 15th Oct 19
Market Action Suggests Downside in Precious Metals - 15th Oct 19
US Major Stock Market Indexes Retest Critical Price Channel Resistance - 15th Oct 19
“Baghad Jerome” Powell Denies the Fed Is Using Financial Crisis Tools - 15th Oct 19
British Pound GBP Trend Analysis - 14th Oct 19
A Guide to Financing Your Next Car - 14th Oct 19
America's Ruling Class - Underestimating Them & Overestimating Us - 14th Oct 19
Stock Market Range Bound - 14th Oct 19
Gold, Silver Bonds - Inflation in the Offing? - 14th Oct 19
East-West Trade War: Never Take a Knife to a Gunfight - 14th Oct 19
Consider Precious Metals for Insurance First, Profit Second... - 14th Oct 19
Stock Market Dow Elliott Wave Analysis Forecast - 13th Oct 19
The Most Successful IPOs Have This One Thing in Common - 13th Oct 19
Precious Metals & Stock Market VIX Are Set To Launch Dramatically Higher - 13th Oct 19
Discovery Sport EGR Valve Gasket Problems - Land Rover Dealer Fix - 13th Oct 19
Stock Market US Presidential Cycle - Video - 12th Oct 19
Social Security Is Screwing Millennials - 12th Oct 19
Gold Gifts Traders With Another Rotation Below $1500 - 12th Oct 19
US Dollar Index Trend Analysis - 11th Oct 19
China Golden Week Sales Exceed Expectations - 11th Oct 19
Stock Market Short-term Consolidation Does Not change Secular Bullish Trend - 11th Oct 19
The Allure of Upswings in Silver Mining Stocks - 11th Oct 19
US Housing Market 2018-2019 and 2006-2007: Similarities & Differences - 11th Oct 19
Now Is the Time to Load Up on 5G Stocks - 11th Oct 19
Why the Law Can’t Protect Your Money - 11th Oct 19
Will Miami be the First U.S. Real Estate Bubble to Burst? - 11th Oct 19
How Online Casinos Maximise Profits - 11th Oct 19
3 Tips for Picking Junior Gold Stocks - 10th Oct 19
How Does Inflation Affect Exchange Rates? - 10th Oct 19
This Is the Best Time to Load Up on These 3 Value Stocks - 10th Oct 19
What Makes this Gold Market Rally Different From All Others - 10th Oct 19
Stock Market US Presidential Cycle - 9th Oct 19

Market Oracle FREE Newsletter

Stock Market Trend Forecast Oct - Dec 2019 by Nadeem Walayat

Trading 101: Position Sizing

InvestorEducation / Learn to Trade Sep 17, 2015 - 03:20 PM GMT

By: John_Mauldin

InvestorEducation

This is going to be the last of the trading lessons for a while. I don’t want to turn this into a trading blog, and there are important macro things to talk about (especially next week).

Here’s an imaginary scenario: someone tips you that an acquisition is going to happen. Of course, that would be insider trading, which is illegal—but let’s pretend for the purpose of this exercise that insider trading were legal.


So someone tells you that Company A is going to buy Company B and is going to pay a 100% premium.

Question: how much of your money do you put in Company B?

If the answer is anything less than “All of it,” then you are an idiot.

We are talking about a 100% return in one day. Can you do better than that? No.

Also, assume that the guy who told you this is 100% reliable. The information is legit. There is no chance that it’s wrong.

Rationally, you should put every penny of your money into Company B stock. If you put in any less than 100%, you are behaving irrationally.

Got it?

Scenario 2: you have a vague idea that GE is going to go up. Just a hunch.

How much GE should you buy?

Answer: not very much. Maybe it should be the smallest position in your portfolio.

At this point in the story, think about your portfolio, or maybe even log into it.

My guess is you have some very high-conviction ideas alongside some very low-conviction ideas, and that everything is just about weighted equally.

People do this all the time. They have $100,000 in 10 stocks—$10,000 a stock—regardless of conviction level.

This is going to be hard for novice traders to understand. Novice traders pick stocks like I bet on baseball. I might bet against the Royals because Edinson Volquez wears his hat sideways, or I might bet on the Nationals because I am a huge Bryce Harper fan, or I might bet against the Red Sox just because.

Novice traders find it hard to believe that someone can be that sure about a stock. But I meet professional gamblers who are “that sure” about baseball games. I don’t understand how they do it, but they do it.

Soros and Druckenmiller were pretty gosh darn sure when they bet against the British pound. Imagine if they had been wrong!

But they knew they wouldn’t be.

Winner, Winner, Chicken Dinner

Let’s go back to about 10 years ago when Ben Mezrich wrote Bringing Down The House: The Inside Story of Six MIT Students Who Took Vegas for Millions. That was when the general public got to learn about advantage play in blackjack, that is, counting cards.

How does it work?

In one paragraph, you count cards so you can keep track of face cards (which are good) and low cards (which are bad), so if you know there’s a concentration of face cards left in the shoe, you will have a temporary statistical advantage over the dealer.

And how do you take advantage of that statistical advantage?

Duh, you bet more!

That’s what the card counters in the book did. When the count was high, they were putting in 10, 20, or even 50 times their normal bet.

In fact, that’s how most casinos know they’re dealing with a card counter. Average players don’t vary their bet size. They bet the same size all the time.

Average traders do too.

If you want to read more on this concept (and I highly recommend that you do), read David Sklansky’s Getting the Best of It.  It’s a gambling book, but most people I know on Wall Street have read it.

Oink

So I’m going to preach what I practice. My highest-conviction position is about 80% of my portfolio (using leverage).

Now, that’s varying your bet size.

Most of my ideas are actually bad. Seriously. I knew a guy at Lehman who said he was wrong 80% of the time. I figured he was lying. The guy made a ton of dough. How could that be true?

If you bet the farm on the 20% of the time you are right, you can do very well.

This, I think, is one of the limitations of an investment newsletter. You have these ideas, and they are in a portfolio, but they are not weighted. Some are clearly better than others. And there they all are, line items in the portfolio update, and the good ones look the same as the bad ones.

A word of caution. Novice traders should not, absolutely not, make one position 80% of their portfolio. I do it because I have 16 years of experience. You should not do this any more than you would bet 80% of your money on a baseball game (unless you know a lot about baseball). Novice traders can’t vary their bet size because they don’t know enough to tell which ideas are bad and which ones are a “sure thing.”

It’s a good way to blow yourself up.

But at some point in your investing career, you are going to come across one of those really great ideas, and you will be tempted to weight it as 10% of your portfolio, along with everything else.

Diversification!

Screw diversification.

How do billionaires get to be billionaires? Funny, if you look at a list of billionaires, there’s not too many money managers in there. Some. Like Dalio, Tepper, Soros, Jones. But not many.

Most billionaires got to be billionaires by starting companies and growing them.

In other words, they had 100% of their portfolio in one stock. Their own.

You don’t get to be a billionaire by putting $10,000 in 10 stocks.

We all can’t be billionaires. But you don’t have to be a piker.

Jared Dillian

If you enjoyed Jared's article, you can sign up for The 10th Man, a free weekly letter, at mauldineconomics.com. Follow Jared on Twitter ;@dailydirtnap

The article The 10th Man: Trading 201: Position Sizing was originally published at mauldineconomics.com.
John Mauldin Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules